The Many Faces of Fraud

A review of the legal definitions of the principal types of fraud will help sharpen our focus in searching for white-collar criminals.  

You may be new to the fraud examination arena or you may have been in the business for decades and you have the low CFE number to prove it. Regardless, you still may want to review the legal descriptions of the principal types of fraud.

Main Fraud Categories
The principal categories of fraud (or white-collar crime) are:

• Misrepresentation of material facts
• Concealment of material facts
• Bribery
• Conflicts of interest
• Theft of money or property
• Theft of trade secrets or intellectual property
• Breach of fiduciary duty

Misrepresentation of Material Facts
This is the offense most often thought of when the term fraud is used. Misrepresentation cases can be prosecuted criminally or civilly under a variety of statutes, such as false statements, false claims, and mail and wire fraud, or they might be the basis for common law claims. The gist of the offense is the deliberate making of false statements to induce the intended victim to part with money or property.

The specific elements of proof of misrepresentation vary somewhat according to the jurisdiction, and whether the case is prosecuted as a criminal or civil action. The elements normally include:

• A material false statement;
• Knowledge of its falsity;
• Reliance on the false statement by the victim; and
• Damages suffered.

In a civil case, it also might be necessary to prove that the victim relied upon the false statements and actually suffered a loss. These elements of proof might not be necessary in a criminal prosecution. Also, in some statutes, materiality is assumed and need not be proved.

In most instances, only false representations of "presently existing facts" may be prosecuted. Opinions and speculative statements about future events, even if made with the intent to mislead, may not be the basis for a fraud case. A used car salesman, for example, who assures the naíve customer that the 20-year-old car that was towed to the lot will give him "years of driving pleasure" probably cannot be prosecuted for fraud. If the other elements are present, the salesman could be prosecuted, however, if he tells the customer that the car has been driven only 15,000 miles when he knows that it has gone 150,000 miles.

The rule limiting fraud cases to misrepresentations of existing facts often is applied to bar fraud claims in contract disputes. A party to a contract who promises to perform certain services by a particular date in the future but who fails to do so generally may not be prosecuted for fraud unless the plaintiff can demonstrate that the defendant had the intent not to perform the promised services when the contract was made. Of course, the other party may file an action for breach of contract.

The rule precluding fraud actions based on false "opinions" is subject to certain exceptions, principally cases involving opinions provided by professional advisers, such as Certified Public Accountants.

An accountant may be prosecuted for fraud who:

• certifies that a financial statement fairly presents the financial condition of the audited company when the accountant knows it doesn't;
• falsely states that the audit was conducted in accordance with generally accepted accounting principles; and
• deliberately distorts the audit results.

Normally, only material false statements may serve as the basis for a fraud case. Materiality usually refers to statements sufficiently important or relevant to the defendant to influence the defendant's decision. For example, a claim that a company enjoyed a 50 percent growth in profits would probably be material to a prospective investor, whereas a statement that the company was considering moving its headquarters from New York City to Chicago might not be. The materiality of allegedly false statements often is a central issue in security fraud cases.

In all fraud cases, the prosecution or plaintiff must prove that a false statement was intentional and part of a deliberate scheme to defraud. Under the law, there's no such thing as an accidental or negligent fraud. In some instances, particularly those involving civil actions for fraud and securities cases, the intent requirement is met if the prosecution or plaintiff is able to show that the false statements were made recklessly; that is, with complete disregard for truth or falsity.

Although a misrepresentation fraud case may not be based on negligent or accidental misrepresentations, in some instances a civil action may be filed for negligent misrepresentation. This action is appropriate if a defendant suffered a loss as a result of the carelessness or negligence of another party upon which the defendant was entitled to rely. Examples would be negligent false statement to a prospective purchaser regarding the value of a closely held company's stock or the accuracy of its financial statements.

Concealment of Material Facts
An action for a fraud may be based on the concealment of material facts, but only if the defendant had a duty in the circumstances to disclose. The essential elements of fraud based on failure to disclose materials facts are:

• that the defendant had knowledge ...
• of a material fact ...
• that the defendant had a duty to disclose ...
• and failed to do so ...
• with the intent to mislead or deceive the other party.

The duty to disclose usually depends on the relationship between the parties. Those people who occupy a special relationship of trust, such as the officers or directors of a corporation, an attorney, accountant, trustee, stockbroker or other agent, may be found to have a duty to fully and completely disclose material facts to the parties who rely upon them. Statutes might expand the duty to disclose to areas in which traditionally there was no such duty, such as to the sellers of personal or real property, or the purchasers or sellers of securities.

Proof that the concealed fact was material probably is the most important element in a concealment case; there can be no liability if the withheld information wouldn't have affected the other party. In addition to fraudulent concealment, a defendant might also be liable for negligent failure to discover and disclose material facts. An accountant, for example, might be liable for failure to discover or report materials facts in a financial statement or audit. Of course, as with negligent misrepresentation, the penalties are less severe for negligence than fraudulent misrepresentation, and there is no criminal liability.

Bribery
Bribery includes official bribery, which refers to the corruption of a public official, and commercial bribery, which refers to the corruption of a private individual to gain a commercial or business advantage. The elements of official bribery vary by jurisdiction, but generally are:

• giving or receiving ...
• a thing of value ...
• to influence ...
• an official act.

The thing of value isn't limited to cash or money. Courts have held that such things as lavish gifts and entertainment, payment of travel and lodging expenses, payment of credit card bills, "loans," promises of future employment, and interests in business can be bribes if they were given or received with the intent to influence or be influenced. Some state statutes might distinguish between felonies or misdemeanors according to the amount of illegal payment.

Proof of corrupt influence often involves demonstration that the person receiving the bribe favored the bribe-payer in some improper or unusual way, such as by providing preferential treatment, bending or breaking the rules, taking extraordinary steps to assist the bribe-payer, or allowing the bribe-payer to defraud the agency or company. It isn't necessary, however, that the prosecution or plaintiff demonstrate that the bribe-taker acted improperly; a bribe might be paid to induce an official to perform an act that otherwise would be legal, or an act that the official might have performed without a bribe. Bribery schemes involving these circumstances, however, are difficult to prove and lack appeal for prosecution.

Illegal Gratuity
An illegal gratuity is a lesser-included offense of official bribery. The elements of an illegal gratuity are:

• giving or receiving ...
• a thing of value ...
• for or because of ...
• an official act.

An illegal gratuity charge doesn't require proof of intent to influence. The statute prohibits a public official from accepting any payment of money or other thing of value other than his lawful compensation. In practice, the statute often is applied when relatively small payments - such as gifts or entertainment - are used to attempt to influence a public official.

Commercial Bribery
Commercial bribery may be prosecuted either as a criminal act or by a civil action. About half of the states have criminal statutes that prohibit commercial bribery. If a state doesn't have a commercial bribery statute, such schemes usually can be prosecuted under criminal fraud statutes on the theory that the payment of a commercial bribe defrauds the business owner of the right to an employee's unbiased and loyal services.

There is no federal statute prohibiting commercial bribery. However, such offenses may be prosecuted at the federal level as mail or wire fraud, or RICO or other violations. The elements of commercial bribery vary by jurisdiction, but typically include:

• giving or receiving ...
• a thing of value ...
• to influence ...
• a business decision ...
• without the knowledge or consent of the principal.

The fifth element is included on the theory that a private business owner isn't defrauded if the owner knows of or allows employees to accept gifts, favors, or other payments from vendors or other business contacts.

Most state commercial bribery statutes are misdemeanors punishable by a jail term of not more than one year. Commer-cial bribery is a felony in Colorado, Kansas, Texas, Arizona (if the value of the bribe payment is $100 or more), and New Hampshire (if the value of the bribe is $500 or more). The New York commercial bribery law is a typical stature that makes it a misdemeanor to give or receive (or to offer or solicit) "any benefit" without the consent of the employer, with the intent of influencing the employee's business conduct. The Louisiana, Michigan, and New Jersey commercial bribery statutes confer immunity on the party to the scheme who first agrees to testify against the other party in a criminal proceeding.

Businesses injured by commercial bribery schemes may sue for treble damages and attorneys' fees under the civil RICO statute (Title 18, U.S. Code, Section 1964) and the Clayton Act (Title 15, U.S. Code, Section 13(c) ), and for compensatory and punitive damages for common law fraud, conflict of interest, and a breach of fiduciary duty. Civil actions may be brought even if commercial bribery isn't a crime in a jurisdiction.

Extortion
An extortion case is often the flip side of a bribery case. Extortion is defined as the obtaining of property from another with the other party's "consent" having been induced by wrongful use of actual or threatened force or fear. Fear might include the apprehension of possible economic damage or loss. A demand for a bribe or kickback also might constitute an extortion. In most states and the federal system, extortion isn't a defense to bribery. That is, a person who makes a bribe payment upon demand of the recipient still is culpable for bribery. In New York, however, extortion may be a defense in certain circumstances.

To be continued in the May/June issue of The White Paper.

This article is excerpted from the Fraud Examiners Manual, 2.201-2.207, Third Edition Updated 2000-2001
©2000 Association of Certified Fraud Examiners.